Some savvy investors in Fannie Mae (FNMA) and Freddie Mac (FMCC) know a little secret that hasn’t got much attention. That little secret is the hidden value of guarantee fees. While the companies have been forced to send all of their profits to the U.S. Treasury over the past few years, this little gem stays hidden off the balance sheet due to some fuzzy accounting.
There’s nothing funny going on here. They’re actually accounting for these guarantee fees just as GAAP accounting recommends (probably). The accountants don’t want them to recognize an asset for the guarantee fees. For some reason, these little gems stay hidden even though they have BILLIONS of dollars in potential value. While it may be difficult to calculate the full value of Fannie Mae and Freddie Mac’s guarantee fees, a quick comparison to mortgage servicing rights gets us a lot closer to an accurate accounting.
What is a guarantee fee?
Like any insurance company, Fannie and Freddie charge a premium for their service of ensuring each mortgage-backed security (MBS). The guarantee fee is simply a small sliver of each mortgage payment which is collected and retained by the GSE’s and used to offset any potential losses. Since 2014, guarantee fees have been about 58 basis points (bp).Â
Most insurance companies earnings are retained and kept set aside for future losses. With Fannie and Freddie they have not been allowed to do this. Regardless, the guarantee fees keep coming in every year and if Treasury and FHFA decide to change the rules, they could actually begin to retain these fees.
To further understand guarantee fees you must also understand other types of similar arrangements. One type of similar arrangement is called a mortgage servicing right (MSR). Like the guaranteed fees, the mortgage servicing right is a sliver of each mortgage payment which is set aside to cover expenses. In this case the mortgage servicing right covers the expenses associated with servicing the mortgage as a financial company. So, if you send your payment to Bank of America, for instance, Bank of America gets to keep a sliver of each mortgage payment as a servicing fee. They show the servicing fee on their income statement each period. When a borrower pays off a mortgage, they stop sending mortgage payments and the fees also stop coming in. So, there is some uncertainty with these payments.
